LegalCrystal – Blog

With the growing liberalization of the Indian economy, a legal due diligence exercise has become a common feature of any investment activity. A legal due diligence process has become necessary for protection of economic interests of the investor and it affords an opportunity for the Indian promoters to be transparent in sharing information, so as to be able to compete with their competitors globally. The Indian promoters have also realized that their effective co-operation in the legal due diligence process is absolutely necessary for the growth of their business.

 Globally, the necessity of a legal due diligence springs out of lack of an independent, reliable and exhaustive information resource on the basis of which an investor can make an informed investment decision. Hence the need to be dependent on promoters for information. In India, though independent searches at some of the government offices (like Registrar of Companies, Registrar of Assurances etc) will help in accumulation of some basic information, it is not possible to base an investment decision on the limited information available at such offices. Resultantly, the ability of the investor to conduct a thorough due diligence and make an informed decision on investment depends on the extent of co-operation given by the promoters.

 A legal due diligence is a precursor to any private equity investment, merger, acquisition, initial public offering or any lending activity in India. The process involving a battery of lawyers, accountants and in some cases tax experts has become so important that in many cases the result of the exercise, will dictate the success of an investment.

So, what does a legal due diligence process involve? Broadly, it involves the following;

       INFORMATION GATHERING: The exercise is a source of information on important matters, which will have a bearing on structuring a transaction. An investor will look to extract information about various matters including ownership of the company, background of the promoters, details of projects being undertaken, the company’s existing commitment to the lenders, rights available to other investors in the company, company’s adherence to corporate governance practices, disputes facing the company and the promoters, company’s strategy to deal with its competitors, permissions required for consummation of the investment etc 

    IDENTIFICATION OF RISK: Knowledge of existing regulatory regime will help a lawyer in identifying the areas of legal non-compliance. Depending on the seriousness of a non-compliance and its consequence, an investor will look to the advise of a lawyer on whether the non-compliance needs to be cured before the investment.

       MITIGATION OF RISK: This is the key element of a legal due diligence process. In the process, the advisor would recommend ways to mitigate the risks identified, so that the company does not face the prospect of being penalized or prosecuted for being on the wrong side of the law. Typically, an investor’s preference would be to engage in a discussion with the legal advisor, understand the consequences of non-compliance and ensure that all non-compliances are cured before the investment proceeds are remitted to the company’s bank account. In respect of non-compliances, which do not have a significant effect on the business, it is also common to find that the investor may prefer such non-compliances to be cured within a specified period after the investment.

      BASIS FOR NEGOTIATION: The issues, which are incapable of cure/ remedy, would form a basis of negotiation, where the parties would need to decide on who is to bear the risks arising in future. In this process of risk allocation, a party may either agree to bear the risk completely or only up to a particular extent. In a private equity investment, these issues are addressed in the representation and warranty (as also indemnity) section of the investment agreement.

An agreement is invariably a result of lengthy negotiation between the investor and the promoters on a whole lot of issues ranging from lock-in on transfer of promoters shares, investors ability to veto certain decisions, promoters ability to start a competing business, special rights available to an investor to exit from the investment, investor participation in formulation of a business plan etc. An effective and a thorough legal due diligence will ensure that the investor has adequate information to be able to make informed decisions.

In a nutshell, investor’s understanding of the way in which the business is being run and the promoter’s understanding of the expectations of the investor is the beginning of a successful Venture.

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Author: Vasudev Dibbur, Amarchand & Mangaldas. The views expressed are personal.

This article is based on the citation: 2007(6) AIR Kar R 151-judgement delivered by Hon’ble Justice N.Kumar of High Court of Karnataka wherein the Hon’ble Justice has threadbare the points with regard to distribution of excess profits by the Companies. For further detailed study , kindly refer the above citation.

When a Company prospers and earns profits it may do one of two things with the profits.  It may either distribute the profits by way of dividend among the shareholders or accumulate them. Ordinarily, these undistributed profits are employed in the business either in acquisition of fixed assets or as working capital and really represent an increase in the capital employed in the business. When these increase to a considerable extent, the issued capital of the company ceases to bear a true relation to the real capital employed in the business.  The company may, in such a case, decide to bring its issued capital into a true relationship with the capital actually employed in the business and may for that purpose capitalize its accumulated profits and issue fully paid up shares or debentures of a nominal value equal to the amount capitalize to its shareholders. These new shares or debentures are called as Bonus Shares or Bonus Debentures. They are not a gift from the company.  They are not issued gratuitously.  Their nominal value is paid in full by the capitalized profits or reserves of the company, which could otherwise have been distributed to the shareholders.

The Company may instead of issuing bonus shares, issue bonus debentures by capitalizing its accumulated profits. The accumulated profits which are capitalized remain in the coffers of the Company and no part of them actually goes into the pockets of the shareholders; the only change that takes place is that the accumulated profits which prior to capitalization were employed in the business as accumulated profits are thenceforth employed as part of the issued or loan capital of the Company according as the issue is of bonus shares or bonus debentures. The accumulated profits which might have been divided among the shareholders as dividend are impounded to increase the capital of Company and what the shareholders get is not any payment out of the accumulated profits but bonus shares or bonus debentures credited as fully paid-up. When such bonus shares or bonus debentures are issued, admittedly no money is paid by the shareholders for the bonus shares or bonus debentures issued to them.  There is no payment of the accumulated profits to the shareholders since no part of the accumulated profits is liberated to them.  The Company does not part with any of the accumulated profits nor do the shareholders receive any part of them.  But the accumulated profits are applied in paying up the capital sums which the shareholders would otherwise have had to contribute for the purchase of new shares or new debentures.

ACT NO. 12 OF 2003

[13th January, 2003.]

An Act to provide, keeping in view of the economic development of the country, for  the establishment of a Commission to prevent practices having  adverse  effect  on  competition, to  promote  and   sustain  competition  in markets, to protect the interests of consumers and  to  ensure  freedom of trade carried on by other participants in  markets, in India, and for matters connected therewith or incidental thereto.

BE it enacted by Parliament in the Fifty-third Year of the Republic of India as follows:-

CHAPTER I

PRELIMINARY

1.   Short title, extent and commencement-

1)   This Act may be called the Competition Act, 2002.

2)   It extends to the whole of India except the State of Jammu and       Kashmir.

3)   It shall come into force on such date as the Central Government may, by notification in the Official Gazette, appoint:

Provided that different dates  may   be  appointed  for   different provisions  of this Act and any reference in any such provision to the commencement  of  this  Act shall be construed as a reference  to  the coming into force of that provision.

2.   Definitions.-In this Act, unless the context otherwise requires -

a) “acquisition” means, directly or indirectly, acquiring or agreeing to acquire-

(i)   shares, voting rights or assets of any enterprise;  or

(ii)   control over management or control over assets of any enterprise;

b) “agreement” includes any arrangement or understanding or action in concert,-

(i)   whether or not, such arrangement, understanding  or  action  is formal or in writing;  or

(ii)   whether or not such arrangement, understanding or action is intended to be enforceable by legal proceedings;

c) “cartel” includes  an   association  of  producers,  sellers, distributors,  traders or service providers who, by agreement amongst  themselves,  limit,  control  or attempt to  control  the  production, distribution,  sale  or price of, or, trade in goods or provision  ofservices;

d) “Chairperson” means the Chairperson of the Commission  appointed under sub-section (1) of section 8;

e) “Commission” means the Competition Commission of India established under sub-section (1) of section 7;

f) “consumer” means any person who-

(i)   buys any goods for a consideration which has been paid or promised  or  partly  paid and partly promised, or under any system of  deferred payment  and includes any user of such goods other than the person who buys  such goods for consideration paid or promised or partly paid  or partly promised, or under any system of deferred payment when such use is  made  with the approval of such person, whether such  purchase  of goods is for resale or for any commercial purpose or for personal use;

(ii)   hires  or avails of any services for a consideration  which  has been paid or promised or partly paid and partly promised, or under any system  of  deferred  payment  and includes any  beneficiary  of  such services  other than the person who hires or avails of the services for  consideration paid or promised, or partly paid and partly promised, or  under  any system of deferred payment, when such services are  availed of with the approval of the first-mentioned person whether such hiring or  availing of services i for any commercial purpose or for  personal use;

g)   ”Director  General” means the Director General  appointed  under sub-section  (1) of section 16 and includes any Additional,  Joint, Deputy or Assistant Directors General appointed under that section;

h) “enterprise” means a person or a department of the Government, who or  which  is, or has been, engaged in any activity, relating to the production, storage, supply, distribution, acquisition or control of articles  or  goods, or the provision of services of any kind,  or  in investment,  or in the business of acquiring, holding, underwriting or dealing with shares, debentures or other securities of any other body corporate,  either  directly  or through one or more of its  units  or is  located at the same place where the enterprise is located or at  a different  place  or  at different places, but does  not  include  any activity of the Government relatable to the sovereign functions of the Government  divisions  or subsidiaries, w ether such unit or division  or subsidiary  nt including all activities carried on by the  departments of  the  Central  Government  dealing with  atomic  energy,  currency, defence and space.

Explanation.-For the purposes of this clause,-

(a)  ”activity” includes profession or occupation;

(b) “article” includes  a new article and “service” includes  a  new service;

(c)  ”unit” or “division”, in relation to an enterprise, includes-

(i)   a  plant  or  factory established for  the  production,  storage, supply, distribution, acquisition or control of any article or goods;

(ii)   any  branch  or  office established for  the  provision  of  any service;

i)    ”goods” means goods as defined in the Sale of Goods Act, 1930  (8 of 1930) and includes-

(A)  products manufactured, processed or mined;

(B)  debentures, stocks and shares after allotment;

(C)  in relation to goods supplied, distributed or controlled in India, goods imported into India;

j) “Member”  means  a  Member  of  the  Commission  appointed  under sub-section (1) of section 8 and includes the Chairperson;

k) “notification“  means  a notification published in  the  Official Gazette;

l)    ”person” includes-

(i)   an individual;

(ii)   a Hindu undivided family;

(iii)  a company;

(iv)  a firm;

(v)   an  association  of  persons or a body  of  individuals,  whether incorporated or not, in India or outside India;

(vi)  any  corporation established by or under any Central,  State  or Provincial  Act  or a Government company as defined in section 617  of the Companies Act, 1956 (1 of 1956);

(vii) any  body  corporate  incorporated by or under the  laws  of  a country outside India;

(viii) a co-operative society registered under any law  relating  to co-operative societies;

(ix)  a local authority;

(x)  every artificial juridical person, not falling within any of  the preceding sub-clauses;

CHAPTER V

DUTIES OF DIRECTOR GENERAL

41. Director-General to investigate contraventions -

1)   The Director General  shall,  when  so  directed  by  the  Commission,  assist  the Commission  in investigating into any contravention of the  provisions of this Act or any rules or regulations made there under.

2)   The  Director General shall have all the powers as are  conferred upon the Commission under sub-section (2) of section 36.

3)  Without prejudice to the provisions of sub-section (2),  sections 240 and 240A of the Companies Act, 1956 (1 of 1956), so far as may be, shall  apply  to an investigation made by the Director General or  any other  person  investigating under his authority as they apply  to  an  inspector appointed under that Act.

CHAPTER VI

PENALTIES

42. Contravention of orders of Commission -

1)   Without prejudice to the provisions of this Act, if any person contravenes,civil prison for a term which  may  extend to one year, unless in the meantime the  Commission directs  his release  and he shall also be liable to a penalty not exceeding rupees ten lakhs. without  any reasonable  ground,  any order of the Commission, or any condition or restriction subject  to which any approval,  sanction  direction  or exemption  in relation to any matter has been accorded, given, made or  granted  under this Act or fails to pay the penalty imposed under this Act,  he  shall  be liable to be detained in

2)   The  Commission may, while making an order under this Act,  issue such directions to any person or authority, not inconsistent with this Act,   as   it  thinks  necessary  or  desirable,   for   the   proper implementation  or execution of the order, and any person who  commits breach  of,  or  fails to comply with, any obligation imposed  on  him  under  such direction, may be ordered by the Commission to be detained in  civil  prison  for  a term not exceeding one year  unless  in  the to  a penalty not exceeding rupees ten lakhs.  Meantime the Commission directs his release and he shall also be liable

43. Penalty for failure to comply with directions of Commission and Director-

General.-If any person fails to comply with a direction given by-

a)   the Commission under sub-section (5) of section 36; or   b)   the  Director  General  while exercising powers  referred  to  in sub-section (2) of section 41, the  Commission  shall impose on such person a penalty of  rupees  one lakh for each day during which such failure continues.

44. Penalty for making false statement or omission to furnish material information.-If any person, being a party to a combination -

a)   makes  a statement which is false in any material particular,  or knowing it to be false;  or

b)   omits to state any material particular knowing it to be material, such  person shall be liable to a penalty which shall not be less than rupees fifty lakhs but which may extend to rupees one crore, as may be determined by the Commission.

45. Penalty for offences in relation to furnishing of information -

1)   Without prejudice to the provisions of section 44, if any person, who furnishes or is required to furnish under this Act any particulars, documents or any information,-

(a)  makes any statement or furnishes any document which he knows  or has reason to believe to be false in any material particular;  or

(b)  omits to state any material fact knowing it to be material;  or

(c)  willfully alters, suppresses or destroys any document  which  is required to be furnished as aforesaid, the  Commission shall impose on such person a penalty which may extend to rupees ten lakhs.

2)   Without prejudice to  the provisions of  sub-section (1), the Commission may also pass such other order as it deems fit.

46. Power to impose lesser penalty -

The Commission may, if  it  is satisfied  that  any producer, seller, distributor, trader or  service provider  included  in any cartel, which is alleged to  have  violated section  3,  has  made a full and true disclosure in respect  of  the alleged  violations  and  such disclosure is vital, impose  upon  such producer,  seller,  distributor, trader or service provider  a  lesser penalty  as it may deem fit, than leviable under this Act or the rules or the regulations:

Provided that lesser penalty shall not be imposed by the Commission in cases  where proceedings for the violation of any of the provisions of this  Act or the rules or the regulations have been instituted or  any investigation  has  been directed to be made under section  26 before making of such disclosure:  Provided further that lesser penalty shall  be  imposed  by the Commission only in respect of a producer,  seller,  distributor,  trader  or service provider included in the cartel,  who first made the full, true and vital disclosures under this section:

Provided  also  that the Commission may, if it is satisfied that  such producer,  seller, distributor, trader or service provider included in the cartel had in the course of proceedings,-

a)   not  complied with the condition on which the lesser penalty  was imposed by the Commission;  or

b)   had given false evidence;

c)   the disclosure made is not vital, and  thereupon  such producer, seller, distributor, trader or  service provider may be tried for the offence with respect to which the lesser penalty  was  imposed  and shall also be liable to the  imposition  of penalty  to which such person has been liable, had lesser penalty  not been imposed.

45. Penalty for offences in relation to furnishing of information -

1)   Without prejudice to the provisions of section 44, if any person, who furnishes or is required to furnish under this Act any particulars, documents or any information,-

(a)  makes any statement or furnishes any document which he knows  or has reason to believe to be false in any material particular;  or

(b)  omits to state any material fact knowing it to be material;  or

(c)  willfully alters, suppresses or destroys any document  which  is required to be furnished as aforesaid, the  Commission shall impose on such person a penalty which may extend to rupees ten lakhs.

2)   Without prejudice to  the provisions of  sub-section (1), the Commission may also pass such other order as it deems fit.

46. Power to impose lesser penalty -

The Commission may, if  it  is satisfied  that  any producer, seller, distributor, trader or  service provider  included  in any cartel, which is alleged to  have  violated section  3,  has  made a full and true disclosure in respect  of  the alleged  violations  and  such disclosure is vital, impose  upon  such producer,  seller,  distributor, trader or service provider  a  lesser penalty  as it may deem fit, than leviable under this Act or the rules or the regulations:

Provided that lesser penalty shall not be imposed by the Commission in cases  where proceedings for the violation of any of the provisions of this  Act or the rules or the regulations have been instituted or  any investigation  has  been directed to be made under section  26  before making of such disclosure:  Provided further that lesser penalty shall  be  imposed  by the Commission only in respect of a producer,  seller,  distributor,  trader  or service provider included in the cartel,  who first made the full, true and vital disclosures under this section:

Provided  also  that the Commission may, if it is satisfied that  such producer,  seller, distributor, trader or service provider included in the cartel had in the course of proceedings,-

1. Short title, commencement and extent.

1)         This Act may be called the Companies Act, 1956.

2)         It shall come into force on such date2* as the Central Government may, by notification in the Official Gazette, appoint. 3[(3) It extends to the whole of India: 4  * * * * *] 5[Provided 6* * * that it shall apply to the  State  of Nagaland subject to such modifications, if any, as the Central Government  may, by notification in the Official Gazette, specify.]

2. Definitions.

In this Act, unless the context otherwise requires –

1)         ”Alter” and “alteration” shall include the making of additions and omissions;

2)         “articles” means  the  articles of  association  of  a company as originally framed or as altered from time to  time in  pursuance of any previous companies law or of  this  Act, including, so far as they apply to the company, the regulations contained, as the case may be, in Table B in  the Schedule  annexed to Act No. 19 of 1857 or in Table A in  the First Schedule annexed to the Indian Companies Act, 1882,  (6 of 1882.) or in Table A in the First

1.   This Act has been extended to Goa, Daman and Diu by Regulation 12  of  1962 (with modifications), s. 3 and Sch.: to Dadra  and  Nagar Haveli by Regulation 6 of 1963, s. 2 and Sch. I and to Pondicherry by Regulation 7 of 1963, s. 3 and Sch.1.The  provisions  of this Act shall apply to Goa, Daman and Diu, subject to the exceptions, modifications and adaptations contained  in the  Schedule  to G.S.R. 615, dated the 24th April, 1965  (Gazette  of India,  Pt.   II, Sec. 3(i), p. 670).  Amended in its application  to Goa, Daman and Diu by Reg.  11 of 1963, s. 9.

2.   1st April, 1956, vide Notification No. S.R.O. 612, dated  8-3- 1956, Gazette of India, Extraordinary, 1956, Pt. II, Sec. 3, p. 473.

3.   Subs.  by Act 62 of 1956 s. 2 and Sch.,  for  sub-section  (3) (w.e.f. 1-11-1956).

4.   Proviso omitted by Act 25 of 1968, s. 2 and  Sch.  (w.e.f. 15-8-1968).

5.   Ins. by Act 31 of 1965, s. 2 (w.e.f. 15-10-1965).

6.   The word “further” omitted by Act 25 of 1968, s. 2  and  Sch. (w.e.f. 15-8-1968).  Schedule annexed to the Indian Companies Act, 1913, or in Table A in Schedule I annexed to this Act;

3)         ”associate”, in relation to a managing agent, means any  of the following, and no others –

(a)        where the managing agent is an individual; any partner or relative of such individual; any firm in which such individual, partner or relative is a partner; any private company of which such individual or any such partner, relative or firm is the managing agent or secretaries and treasurers or a director or the manager; and any body corporate at any general meeting of which not less than one-third of the total voting power in regard to any matter may be exercised or controlled by any one or more of the following, namely, such individual, partner or partners, relative or relatives, firm or firms; and private company or companies;

(b)        where the managing agent is a firm: any member of such firm; any partner or relative of any such member; and any other firm in which any such member, partner or relative is a partner; any private company of which the firm first mentioned, or any such member, partner, relative or other firm is the managing agent, or secretaries and treasurers, or a director, or the manager; and any body corporate at any general meeting of which not less than one-third of the total voting power in regard to any matter may be exercised or controlled by any one or more of the following, namely, the firm first mentioned, any such member or members, partner or partners, relative or relatives, other firm or firms and private company or companies;

(c)        where the managing agent is a body corporate:

(i)         Any subsidiary or holding company of such body corporate; the managing agent or secretaries and treasurers, or a director, the manager or an officer of. The body corporate or of any subsidiary or holding company thereof; any partner or relative of any such director or manager; any firm in which such director, manager, partner or relative, is a partner;1 * * *

(ii)         any other body corporate at any general meeting of which not less than one-third of the total voting power in regard to any matter may be exercised or controlled by any one or more of the following, namely, the body corporate and the companies and other persons specified in paragraph (i) above; and 2[(iii)any subsidiary of the other body corporate referred to in paragraph (ii) above: Provided that where the body corporate is the managing agent of the other body corporate referred to in paragraph (ii) above, a subsidiary of such other body corporate shall not be an associate in  relation to the managing agent aforesaid ; and]

(d)        where the managing agent is a private company or a body corporate having not more than fifty members: in addition to the persons mentioned in sub clause (c),  any member of the private company or body corporate;

Explanation.-If one person is an associate in relation to another within the meaning of this clause, the latter shall also be deemed   to be an associate in relation to the former within its meaning;

4)         ”Associate”, in relation to any secretaries and treasurers, means any of the following, and no others –

(a)        where the secretaries and treasurers are a firm: any member of such firm; any partner or relative of any such member; and any other firm in which any such member, partner or relative is a partner any private company of which the firm first-mentioned, or any such member, partner, relative or other firm is the managing agent, or secretaries and treasurers, or a director, or the manager ; and any body corporate at any general meeting of which not less than one-third of the total voting power in regard to any matter may be exercised or controlled by any one or more of the following, namely, the firm first-mentioned, any such member or members, partner or partners, relative or relatives, other firm or firms, and private company or companies;

(b)        where  the secretaries and treasurers are a body corporate –

(i)         any subsidiary or holding company of such body corporate; the managing agent or secretaries and treasurers, or a director, the manager or an officer of the body corporate or of any subsidiary or holding company thereof ; any partner or relative of any such director or manager; any firm in which such director or manager, partner or relative, is a partner; 1 * * *

(ii)         any other body corporate at any general meeting of which not less than one-third of the total voting power in regard to any matter may be exercised or controlled by any one or more of the following, namely, the body corporate and the companies and other persons specified in paragraph (i) above; and 2 [ (iii) any subsidiary of the other body corporate referred to in paragraph (ii) above: Provided that where the body corporate is the secretaries and treasurers of the other body corporate referred to in paragraph (ii) above, a subsidiary of such other body corporate shall not be an associate in relation to the secretaries and treasurers aforesaid; and]

(c)        Where the secretaries and treasurers are a private company or a body corporate having not more than fifty members: in addition to the persons mentioned in sub-clause (b), any member of the private company or body corporate;

Explanation.-If  one  person is an associate in  relation  to another  within the meaning of this clause, the latter  shall also  be deemed to be an associate in relation to the  former within its meaning;